Chapter 7 Consumers Producers and the Efficiency of Markets Welfare economics the study of how the allocation of resources affects economic well being Consumer Surplus Willingness to pay o The maximum amount that a buyer will pay for a good o Consumer surplus the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it If someone is willing to pay 100 for an item and pays only 80 for it he receives consumer surplus of 20 Using the Demand Curve to Measure Consumer Surplus o Ex If price of an item is above 100 the quantity demanded in the market is 0 because no buyer is willing to pay that much If price is between 80 and 100 quantity demanded is 1 because only 1 buyer is willing to pay such a high price If price is between 70 and 80 quantity demanded is 2 because 2 buyers are willing to pay the price Overall the demand schedule is derived from willingness to pay of total possible buyers o Because demand curve reflects buyers willingness to pay we also use it to measure consumer surplus In a graph the area below the demand curve and above the price measures the consumer surplus in a market How a Lower Price Raises Consumer Surplus o Because buyers always want to pay less for the goods they buy a lower price makes buyers of a good better off o Consumer surplus is the area above the price and below the demand curve o If the price is lowered there is additional consumer surplus to the initial customers which is added onto the initial consumer surplus There is also consumer surplus to new customers What Does Consumer Surplus Measure o Our goal in developing the concept of consumer surplus is to make judgments about the desirability of market outcomes o Consumer surplus measures the benefit that buyers receive from a good as the buyers themselves perceive it o In most markets consumer surplus reflects economic well being Economists normally assume that buyers are rational when they make decisions Producer Surplus Cost and the Willingness to Sell o Cost the value of everything a seller must give up to produce a good o Producer surplus the amount a seller is paid for a good minus the seller s cost of providing it Measures the benefit sellers receive from participating in a market Using the Supply Curve to Measure Producer Surplus o Producer surplus is closely related to the supply curve o Ex Painters If price is below 500 none of the painters is willing to do the job so the quantity supplied is zero If price is between 500 ad 600 only 1 person is willing to do the job so quantity supplied is 1 If price is between 600 and 800 2 people are willing to do the job so quantity supplied is 2 and so on o At any quantity the price given by supply curve shows the cost of the marginal seller the seller who would leave the market first if the price were any lower o The area below the price and above the supply curve measures the producer surplus in a market The height of the supply curve measures sellers costs and the difference between price and cost of production is each seller s producer surplus How a Higher Price Raises Producer Surplus o Sellers always want to receive a higher price for the goods they sell o When the price rises additional producer surplus to initial producers is added to initial producer surplus There is also producer surplus to new producers added o We use producer surplus to measure the well being of sellers o Efficiency the property of a resource allocation of maximizing the total surplus received by all members of society o An allocation is inefficient if a good is not being produced by the sellers with lowest cost Allocation is inefficient if a good is not being consumed by the buyers who value it most highly o Equality the property of distributing economic prosperity uniformly among the members of society Evaluating Market Equilibrium o The total area between the supply and demand curve up to the point of equilibrium represents the total surplus in the market o When a market is in equilibrium the price determines which buyers and sellers participate in the market Those buyers who value the good more than the price choose to buy the good while those who value it less than the price do not Those sellers whose costs are less than the price choose to produce Market Efficiency and sell the good sellers whose costs are greater than the price do not o Free markets allocate the supply of goods to the buyers who value them most highly as measured by their willingness to pay o Free markets allocate the demand for goods to sellers who can produce them at the least cost o Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus o Markets do not allocate resources efficiently in the presence of Market Failures market failures o Market power In some markets a single buyer or seller may be able to control market prices It can cause markets to be inefficient because it keeps the price and quantity away from equilibrium of supply and demand o Externalities side effects such as the use of agricultural pesticides affecting not only manufacturers who make them and the farmers who use them but many others who breathe air or drink water that has been polluted by the pesticides Externalities cause welfare in a market to depend on more than just the value to the buyers and the cost to the sellers Because buyers and sellers do not consider these side effects when deciding how much to consume and produce the equilibrium in a market can be inefficient from the standpoint of society as a whole
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